California legislators are currently reviewing and amending a proposed bill that could have a major impact on the profitability and success of the state’s fledgling legal adult-use and medical cannabis industry. Introduced in mid-March, Bill AB 3157 seeks to temporarily cut the cannabis Excise Tax – from 15% to 11% – and suspend the Cultivation Tax, until June 1, 2021.

The subsequent decrease in overhead costs is intended to both persuade more entrepreneurs to join the legal cannabis market, and lower the final sale costs to compete with black market operators.

Giving California’s Legal Cannabis Market a Break

In a statement coinciding with the introduction of AB 3157, Assemblymember Tom Lackey (R-Palmdale) laid out his reasoning for the proposed tax cut: ““Criminals do not pay business taxes, ensure consumers are 21 and over, obtain licenses or follow product safety regulations. We need to give legal businesses some temporary tax relief so they do not continue to be undercut by the black market.”

Many cannabis entrepreneurs, business operators, advocates and consumers have noted steep increases in the cost of cannabis since legalization January 1, 2018. The combination of the cannabis Excise Tax, Cultivation Tax, sales tax, corporate taxes, state and local regulations, and fees related to licensing, have created a significant financial hurdle for those seeking entry into the industry, and operating businesses suffer a deep cut out of profits and must increase final sale costs to stay profitable. Meanwhile, California’s sophisticated and entrenched black and grey market cannabis operations are free from these financial burdens and have been able to undercut the legally operating market.

“California cannabis businesses are making significant investments as they embrace the regulated marketplace while, at the same time, being undercut by unregulated competitors,” stated Assemblymember Rob Bonta (D-Oakland), one of the authors of the bill. “AB 3157 reduces the tax burden on the licensed cannabis market during this transition period, keeping customers at licensed stores and helping ensure the regulated market survives and thrives.”

What Kind of Impact Could AB 3157 Have?

As reported by Leafly, data analytics company New Frontier Data performed an analysis of AB 3157 and concluded that the proposed changes would reduce consumer prices by up to 9%. In a statement, senior economist Beau Whitney said: “By lowering the excise tax and postponing the cultivation tax, it will lower the overall price for consumers at the register, which will also reduce the differential between illicit and legal prices. Reducing this gap is critical to making the legal market more competitive against the illicit market and more attractive for consumers.”

Similar efforts have had a positive impact on other legal adult-use cannabis states. Colorado, Washington and Oregon have all taken steps to reduce their cannabis tax rate and incentivize the adoption of the legal market.

Eliminating the Cannabis Black Market

The Adult Use of Marijuana Act (AUMA) explicitly states that one of the purposes of cannabis legalization is to: “tax the growth and sale of marijuana in a way that drives out the illicit market for marijuana and discourages use by minors and abuse.” In other words, a driving motivation for cannabis legalized is an effort to drive the illegal and dangerous cannabis black market out of business.

AB 3157 is based on the understanding that the current rate of cannabis taxation goes against this core goals of AUMA. If the legal market cannot compete with the black market, the mission of cannabis legalization fails.

Benefits of a Lowered Tax Rate for the Cannabis Industry

The Cannabis Industry specialists at MGO have been working closely with a wide variety of cannabis entrepreneurs before, and following, the 1/1/2018 legalization. While many operations are growing and thriving, it is easy to see that lowering the tax burden would create many benefits for the industry, including:

Increasing profits for legally-operating cannabis businesses;

Lowering the final sale cost of cannabis, drawing more consumer to legal sources; and

Incentivizing black and grey market operations to operate legally.

How Likely is it AB 3157 Becomes Law?

Bi-partisan support for AB 3157 – announced by Assemblymembers Tom Lackey (R-Palmdale) and Rob Bonta (D-Oakland) – suggests a reasonable likelihood that the bill could become law. The bill has also received widespread support outside the lawmakers’ circle. Cannabis Grower’s Association (CGA) lists AB 3157 as “high priority,” and Jennifer Schwab, Representative of the International Brotherhood of Teamsters, released the following statement of support: “One of the biggest threats to workers in the emerging legal cannabis industry is diversion of cannabis into the illegal market, which undermines our employers and our jobs. Lowering the tax rate on cannabis will encourage cannabis businesses to choose the legal market, which helps the entire industry and protects our members’ jobs.”

Additionally, as stated above, there is a precedent as several other states have revised their initial cannabis tax structures and seen significant success. For example, Washington’s statewide revenue more than doubled – Increasing from $13.4 million in June of 2015 (final month of initial tax rate) to $33.1 million in April of 2017 – after the tax structure was simplified and rates were lowered.

AB 3157 has made the usual rounds of committee review and revision since its introduction on 3/22/2018, but no final version or vote date have been set.

MGO’s Final Thoughts

MGO’s advisors are in the field diligently working alongside cannabis business operators as we seek to create and implement best practices for taxes, reporting and regulatory compliance. We will be keeping close watch of AB 3157 as it moves through California’s legislation, and will provide regular updates of significant changes.

If you have questions about AB 3157, cannabis tax payments, or cannabis industry business best practices, please reach out to us.

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This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction.